Global Challenge for Dollar’s Crown Has Euro Set for More Gains
Europe’s resurgent common currency is looking powerful enough to fuel talk of it rivaling the dollar’s supremacy.
The common currency has rallied about 12% since virus turmoil shook markets in March, buoyed by the European Union’s policy response to the crisis and as the Federal Reserve looks set to keep rock-bottom interest rates that are weakening the dollar.
Hedge funds are now betting on another jump higher to $1.25 after the U.S. elections, a level also targeted by Goldman Sachs Group Inc. The wagers have fueled the most bullish August on record in the options market.
It’s part of a wider trend that’s got Mizuho International Plc strategists bestowing the title of king of currencies on the euro -- an accolade normally reserved for the greenback -- as uncertainty around November’s U.S. presidential vote helps to further burnish the appeal of European assets.
“There is plenty of time for the ‘King Euro’ theme to run,” said Peter Chatwell, head of multi-asset strategy at Mizuho. “It can compete with the dollar for being the western currency of choice for trade purposes, and can compete more generally with other safe haven currencies as being a credible, long-term store of capital.”
The euro climbed 0.7% to $1.1902 at 8:36 a.m. in New York on Friday, as a gauge of the greenback slumped to a two-year low in the wake of Fed Chair Jerome Powell allowing U.S. inflation to run higher. That dollar trend is likely to continue for Jim Caron, a portfolio manager at Morgan Stanley Investment Management.
While the dollar typically gains in the months after election results, a win for President Donald Trump’s challenger Joe Biden could hurt the currency next year as the Democratic nominee has called for boosting taxes on wealthier Americans and increasing federal spending to spur a U.S. economy battered by the pandemic. Biden is leading in the polls.
“Building expectations for a Democratic sweep have likely played a role in weakening the dollar and strengthening the euro,” said Lee Hardman, foreign exchange strategist at MUFG Bank Ltd. in London. “Whether that continues ahead of the election will depend on whether the race tightens or not.”
Of course, other factors will also determine the euro’s future, not least the extent to which the region’s growth outpaces that of the U.S., and how well both sides of the Atlantic manage to control the continued spread of the coronavirus.
And forecasting market moves after an election is more of an art than a science. Either way, the vote is now the key event on traders’ horizons. Option markets show investors bracing for turbulence in the euro-dollar pair three months from now, then seeing volatility cool off gradually.
That’s not stopping hedge funds from betting the euro will trade above $1.25 after the elections, according to traders and brokers in Europe familiar with the transactions, who asked not to be identified because they aren’t authorized to speak publicly.
“We expect the euro-area economy to outperform other countries and see the euro as under-owned in international portfolios and under-valued in our fair value models,” Goldman Sach’s Chief European Economist Jari Stehn wrote in a note with colleagues.
Renewed optimism is also being reflected in options trades that have gone through the Depository Trust & Clearing Corporation this month. August has seen the greatest demand for exposure to euro gains since Bloomberg began compiling data, at twice the volume of bets on a downturn.
Some investors are placing sizable bets for an even bigger surge to $1.28 next year. That would take it to the highest since 2014. Other gauges of market positioning and sentiment for the next two years are flashing levels of bullishness on the euro seen only a few times in more than a decade.
Still, analysts say that in the shorter term the Biden effect may already be priced in. While MUFG forecasts the euro to end the year up about 1.5% at $1.20, it recently suggested tactically selling the euro against the dollar, expecting a correction after the common currency’s sharp gains. The median forecast in a Bloomberg survey sees the euro at $1.18 in both the third and fourth quarters of 2020, below its current level.
The euro’s rally could stall or backtrack if Trump wins a second term, unraveling regulation and delivering business-friendly policies. Bad news could also come if the virus leads to renewed lockdowns in Europe and sluggish economic data.
The market’s consensus for a stronger euro could in fact make a further spike less likely, said John Roe, head of multi-asset funds at Legal & General Investment Management Ltd. in London. “For us that’s a warning sign,” he said. “Our tendency would be to look to go the other way as a result.”
But that’s an increasingly niche view. Regardless of the U.S. election, Standard Bank’s head of foreign-exchange strategy Steven Barrow also sees the euro climbing to $1.25 in six months. That would take it back to levels seen in early 2018, before two years of steady declines shook the faith of those calling for an end to the U.S. dollar’s hegemony.
And on the euro’s side, the agreement among EU leaders over a recovery fund has boosted the common currency’s credibility. That followed a myriad of political troubles that led investors to question if the bloc could stay together, from Brexit to Italy’s budget fights with the EU and pressure on the leaders of France and Germany.
“My view is the dollar is going down and it doesn’t matter who wins,” Standard Bank’s Barrow said. “Countries like the U.S. have developed these huge current-account deficits that require inflows of capital, and the U.S. is going to stretch that further. U.S. assets are perhaps overvalued.”
©2020 Bloomberg L.P.